Investors and consumers expected President Donald Trump to be a pro-business billionaire. What they got instead was Tariff Man.
The Unforeseen Consequences of Tariffs
As Trump was preparing for his second term in office, stocks were soaring, consumers were buoyant and economists were feeling optimistic about the year ahead, their hopes fed by potential pro-growth policies like tax cuts and deregulation.
Fast forward to now, when Trump has imposed 25 percent duties on imports from Canada and Mexico and increased existing tariffs on China. Americans have gotten gloomier about what tariffs might mean for their wallets, consumer surveys show. The odds of a recession have risen. And stocks are roughly where they stood on Election Day, facing a punishing rout as Trump’s new tariffs took effect and largely erasing the gains since he took office.
Everyone should have seen this coming. Trump often talked about tariffs on the campaign trail. He also threatened tariffs after he was elected. Then, he threatened more tariffs after he was sworn in. And yet, investors — like everyone else — weren’t sure how seriously to take those warnings until this week.
“They’re believing him more now,” said Neil Dutta, head of U.S. economic research at Renaissance Macro Research. “He finally shot the hostage.”
The Economic Shift Caused by Tariffs
Trump’s move to shatter supply chains across North America is a stunning development, no matter how foreseeable, and it’s changing the U.S. outlook fast. The U.S. economy was not entirely out of the inflation woods when Trump took office, but steady consumer spending and a low unemployment rate normally provide a healthy buffer against smaller economic shocks.
But throwing new tariffs on top of broader policy uncertainty and potential economic ripple effects from Elon Musk’s Department of Government Efficiency will mean a hit to growth. The question is how large of a hit it will ultimately be.
“People who would never even think about recession now suddenly have to consider it,” said Mohamed El-Erian, chief economic adviser at Allianz, the parent company of asset management giant PIMCO. “It’s been an incredible transformation in the last four weeks.”
The Debate Over Tariffs and Economic Growth
Essentially, Trump, who seems to care about economic stats and the stock market more than almost any other barometer of success, may be knee-capping his own record.
Of course, administration officials argue that’s not the case. Though Trump told reporters in early February that Americans could feel “some pain” from the trade wars, he and his advisers have argued tariffs aren’t a barrier to growth.
In a speech last week, Treasury Secretary Scott Bessent said tariffs would boost investment, improve national security and increase government revenues. Stephen Miran, nominated to be Trump’s chief economist, said at his confirmation hearing Thursday that “the American economic story has seen periods of high tariff rates coincide with extraordinary economic success,” citing the 1800s and the post-World War II period.
The Potential Impact on GDP and Consumer Spending
Some level of slowdown is essentially guaranteed. Even in Trump’s first term, when tariffs he imposed were much smaller in scope, business investment suffered and the manufacturing sector fell into contraction, prompting the Federal Reserve to cut interest rates in late 2019 amid concern for slowing growth.
This time around, the additional tariffs on Canada, Mexico and China alone could shave a percentage point off of GDP growth, according to Brad Setser, a senior fellow at the Council on Foreign Relations who served in economic roles under both Presidents Barack Obama and Joe Biden.
That estimate is based on the “just-pay-it” cost that assumes trade flows stay the same and companies merely pay the tariff, though there could be less damage if companies absorb the higher import costs, or there could be more if some firms decide to stop producing in certain countries altogether.
The Federal Reserve’s Response to Tariffs
The trade actions so far could take a huge bite out of consumer spending, which is the main engine of growth. But they likely won’t be enough, on their own, to shrink the economy. Still, Trump’s tariff wars are far from over. “There’s a quite significant tariff escalation that seems to be built in in early April,” and the scope of those tariffs could “clearly threaten a recession,” Setser said.
Now, Trump’s tariffs will cause a dilemma for Fed Chair Jerome Powell, who has kept borrowing costs at elevated levels in an attempt to bring inflation to heel but has also committed to trying to keep the economic expansion going. If Trump doesn’t reverse course soon, economic activity will likely weaken, putting pressure on the Fed to lower rates to provide relief to the economy even if tariffs push up prices faster and reignite inflation fears.
Conclusion
Renaissance Macro’s Dutta told me it’s telling that Trump still followed through even though markets were shaky before he committed to tariffing Mexico and Canada. He pointed to the expectation that Powell will only let markets drop so much before intervening — known in investor circles as “the Fed put,” a reference to a type of bet known as a put option — and said there was also a “Trump put.”
“We’re trying to figure out, where is the Trump put, and where is the Fed put?” Dutta said. “In both cases, they might be a little lower than where we think.”
In other words, Trump’s financial pain tolerance is probably higher than we all thought. Adjust your expectations accordingly.
